Inflation Shows Signs of Life
Inflation increased last month, as higher costs in housing, medical care, and wireless services offset lower energy and vehicle prices (Figure 1).
Figure 1: A Rise in Inflation
Sources: Thomson Reuters Datastream, New York Life Investments, as of 9/30/15. Past performance is no guarantee of future results, which will vary. It is not possible to invest directly in an index.
2017 will likely be remembered for elusive inflation. Investors, economists, and even central bankers are baffled by low inflation amid low unemployment, record job openings, and a growing economy. However, the improvement in October’s consumer price report suggests that inflation may be strengthening.
The fears of deflation that troubled markets are now largely behind us. And with signs of life in inflation, the Federal Reserve is set to raise rates in December and to continue tightening in 2018.
Markets agree, pricing with near certainty the probability of a rate hike in December. Next year, however, the market is more skeptical, pricing in only half of the hikes that the Fed has signaled.
This tug of war between the Fed and Markets comes as no surprise. Structural changes, due to aging demographics and the rapidly expanding digital economy, continue to drive down supply chain costs and retail prices.
Inflation is very susceptible to momentum. Rising prices and wages can easily snowball into even higher prices and even higher wages. For now, the snowball hasn’t gained much momentum, but stronger global growth and many job openings should push consumer prices and interest rates higher by the end of 2018 (Figure 2).
Exposure to assets that historically have performed well amid inflation, such as commodities, is prudent at this stage of the cycle.
Figure 2: Jobs Hard to Fill vs. Wage Growth
Source: Thomson Reuters Datastream, as of 11/20/1985. Past performance is no guarantee of future results, which will vary.
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